ECON 101. GAME THEORY

What Is Game Theory?

Game theory is a theoretical framework for imagining social scenarios in which competitive players interact. Game theory is, in some ways, the study of strategy, or at least the optimal decision-making of independent and competing actors in a strategic situation.

KEY THOUGHTS

Game theory is a theoretical framework for imagining social scenarios in which competitive players interact.

Game theory's goal is to achieve optimal decision-making among autonomous and competing actors in a strategic framework.

Real-world scenarios for circumstances such as pricing competition and product releases (among many others) can be sketched out and their consequences anticipated using game theory.

Among the many scenarios are the prisoner's dilemma and the dictator game.

Cooperative/non-cooperative, zero-sum/non-zero-sum, and simultaneous/sequential game theory are some examples.

How Game Theory Works

In the 1940s, mathematician John von Neumann and economist Oskar Morgenstern were significant pioneers of game theory.

Many consider John Nash, a mathematician, to be the first substantial extension of von Neumann and Morgenstern's work.

The game, which serves as a model of an interaction scenario among rational participants, is the center of game theory. The essential concept in game theory is that one player's payoff is dependent on the strategy used by the other player.

The game determines the identities, preferences, and available strategies of the players, as well as how these strategies effect the outcome. Depending on the model, additional needs or assumptions may be required.

Psychology, evolutionary biology, military, politics, economics, and business are all areas where game theory can be applied.

Useful Terms in Game Theory

When there are two or more players and known payments or quantifiable effects, we can use game theory to assist estimate the most likely outcomes. Let us begin by identifying a few words often used in game theory research:

A game is any set of circumstances in which the outcome is determined by the acts of two or more decision-makers (players).

Players: A strategic decision-maker inside the game's context

Strategy: A comprehensive plan of action that a player will employ in response to a set of situations that may emerge during the course of the game.

Payoff: The amount of money a player earns for achieving a specific result. (The reward can take any measurable form, from cash to utilities.)

The Nash Equilibrium

Nash equilibrium is a result that, if achieved, ensures that no player can improve payoff by making unilateral decisions. It can also be interpreted as "no regrets," in the sense that after a decision is taken, the player will have no regrets about the implications of that decision.

In most circumstances, the Nash equilibrium is reached over time. However, once the Nash equilibrium is attained, it cannot be broken. Consider how a unilateral move would change the situation after we've learned how to locate the Nash equilibrium. Does that make sense? It shouldn't, which is why the Nash equilibrium is referred to as "no regrets." In general, a game can have more than one equilibrium.